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@K.R.Bhattarai, Business School, University of Hull
1
Economic Modelling
Lecture 1Introduction to Economic ModellingOutline of the SyllabusBasic skills required for the Module
@K.R.Bhattarai, Business School, University of Hull
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Economics Modelling (26214)Lectures and Tutorial Meetings and Office Hours
Lectures Day Time Room
Monday 2:15 WI-S 25 Tuesday 4: 15 Loten- LRD
Wednesday 12:15 Larkin-LTATutorials
Day Time RoomTuesday 3:15 WI-S10
Thursday 9:15 WI-S 26Office hours:
Monday 12:05 - 2:05 369 WilberforceTuesday 1:05 - 3:05 369 Wilberforce
Midterm Exam Thursday March 4, 2004Essay Due Thursday April 1 2004 by 4 PM (hand in at School Office)
Reading Week Starts February 23rd.
@K.R.Bhattarai, Business School, University of Hull
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What is an Economic Model?• An abstract map of an economy• Way of systematic thinking on
– how the value of one variable determines the value of another variable.– How one set of variables determine another set of variables
• Language that economists speakA Model contains
– endogenous variables– exogenous variables– Parameters– Assumptions– Solutions
Representation of model: Diagrams and equations– linear or non-linear, single or multiple equations, – static or dynamic or strategic– Theoretical (abstract) or appliedUsed of Model : analysis of behaviour, facts or evaluation of a
policy
@K.R.Bhattarai, Business School, University of Hull
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Major Economic Questions
• Why levels and rate of growth of income are different over time and in different countries?
• What determines aggregate demand and aggregate supply in an economy in the short run?
• How do households and firms make their consumption and investment decisions?
• How can fiscal and monetary policy measures taken by the government affect decision of households and firms in an economy?
• What causes fluctuations in income, employment, prices, revenue and spending of government, imports and exports in economy?
• What kind of models can explain making of economic policy for higher rate of growth and for stability of an economy?
• What is the link between home and foreign economies? How to be most competitive and efficient in allocating scarce resources in an economy?
@K.R.Bhattarai, Business School, University of Hull
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1960 1970 1980 1990 2000
0
20
40Algeria Ghana
1960 1970 1980 1990 2000
0
5UnitedKingdom UnitedStates
1960 1970 1980 1990 2000
0.0
2.5
5.0
7.5Germany France
1960 1970 1980 1990 2000
-5
0
5
10India
1960 1970 1980 1990 2000
-20
0
20China
1960 1970 1980 1990 2000
0
10Japan Korea
1960 1970 1980 1990 2000
0
10Singapore Malaysia
1960 1970 1980 1990 2000
0
5
10 Netherlands Ireland
Variation in Growth Rates Across Economies
Graphics Using Givewin (Doornik and Hendry (2001)) and Data from the World Bank CD (start/applications/Economics)
@K.R.Bhattarai, Business School, University of Hull
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Module Contents
Analysis of Economic growthAnalysis of Macroeconomic Fluctuation
– Analysis of Macroeconomic Fluctuations using the IS-LM, AS-AD Models
– Unemployment and Inflation
Fiscal and Monetary policy for internal and external stabilityRole of Financial Market in the EconomyExchange rate and Balance of PaymentMicro-foundation on Consumption and Investment and
general equilibrium impacts of taxesPolicy game
@K.R.Bhattarai, Business School, University of Hull
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Module Requirements
• Activities: 22 Lectures; 10 TutorialsSmall in-class mock tests and quizzes
Assessment• Course Work counts 50 percent of the module marks
In class Mid-term exam counts 25 percent will be held on Thursday March 4, 2004
Term paper counts 25 percent Due Thursday April 1, 2004
• Final Exam counts 50 percent (After Easter between April 26 -May 10)
• Reassessment by two hours’ written exam
@K.R.Bhattarai, Business School, University of Hull
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An Overview of Decision Makers and Players in an Economy
HouseholdsConsumers
Firms – InvestorsProducers
Banks –Central Bank
Commercial BanksStock Market
Financial Institutions
Trade Unions Employer
Unions
Merchants and Traders
–Wholesalers–Retailers
Revenue – Tax Collector
Treasury –Allocation of Public Funds
Economy:The Big Market
(prices and quantities)
Rest of the World (ROW) –
Trading PartnersMultilateral Organisation
@K.R.Bhattarai, Business School, University of Hull
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Economy(p, w, y, c, l, L)
Firms (producers) Max π(LS)
Households (consumers)Max U(C,L)
Labour supply, L
Wage payment, wL
Supply of Goods
Payments for goods, p.y
1lcUMax1 LSlwLSpc
0;0;0 LSlc
wLDpyMax LDy
0;0 LDy
Market p and w such thatY = CLD = LSLS +l = L
Micro-Foundation to Macro VariablesGeneral Equilibrium with a representative household and firm
@K.R.Bhattarai, Business School, University of Hull
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Personal disposable
income
Personal incomeNational
income
NDP
GDP
C
Indirect taxes
Depreciation
I
G
X-Z
GDP, GNP, National and Disposable Incomes
@K.R.Bhattarai, Business School, University of Hull
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Keynesian Static Model of National Income
Y = C + I + G ; C = a0 + a1(Y-T)Endogenous variables Y, C and Exogenous variables G, IParameters: a0 and a1.
C =200 + 0.8*(Y-T) ; T =20; G=20; I =30 Solving the model: Y = (a0 - a1T+I+G)/(1-a1)Y =200 +0.8*(Y-T) +I +GY-0.8Y = 200 -0.8*(20) +30+200.2 Y =200-16 +50Y =234/0.2 = 5*(234) = 1170C = 200+0.8*(1170-20) = 1120
Checking the validity of the solution:Y =1170 =1120+20+30 = C + I + GMULTIPLIER = (1/(1-0.8))=5
@K.R.Bhattarai, Business School, University of Hull
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Keynesian Dynamic Model of National Income
Yt= Ct + It + Gt Current consumption depends on past income
Ct =200 + 0.8*(Yt-1 -Tt-1)
Tt-1 =20; Gt =20; It =30; Yt-1 = 500
Yt =200 +0.8*(500-20) +30 +20
Yt = 200 +384 +30+20
Yt =200+384 +50 = 634Assume Tt, It , Gt remain same for all years
Yt+1 = 200 +0.8*(634-20) +30 +20 = 741Solve this model for another 20 years.
@K.R.Bhattarai, Business School, University of Hull
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Macroeconomic Policy
• Fiscal Policytaxesexpenditure debt
• Monetary Policy
interest rate/ M-supply
exchange rate/trade
stock market• Growth/supply side
@K.R.Bhattarai, Business School, University of Hull
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Minimum Mathematical Skills Required in this Module
• Diagrams to represent one or two equations• Basic Algebra: Addition, Subtraction, multiplication and division with
calculator and excel• Solution of Simultaneous equations• Graphs and Charts in excel and Givewin• Six rules of approximation• Five rules of log• Four rules of differential• Power rule in algebraic expressions• Calculations using spreadsheets• Modelling Strategic moves (about the end of the term)
– Normal, Extensive form of a GAME– Dominant Strategy and Nash equilibrium– Dynamic Game: Subgame perfect equilibrium
@K.R.Bhattarai, Business School, University of Hull
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Six rules of approximation for small numbers
eieir 1
111
LWY
gg 111
rr
1ln
WLY ggg
L
Yy
LYy ggg
ngg n 11
I. Log
II. Product
III. Division
IV. Growth of a product
V. Growth of a Ratio
X
nXn
XXXS
1
11
....2
1VI. Sum of a geometric Series
@K.R.Bhattarai, Business School, University of Hull
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Five Rules of log
I. Power Rule
II. Product Rule
III. Quotient Rule
IV. Log of Exponentials
KY lnln KY
PYR PYR lnlnln
L
Yy LYy lnlnln
gtt eYY 0 gtYYt 0lnln
V. Differentiation of log with respect to time
t
tt
Y
dY
dt
Yd
ln
@K.R.Bhattarai, Business School, University of Hull
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Four Rules of Differentiation
I. Power Rule
II. Product Rule
III. Quotient Rule
IV. Chain Rule
1 KK
YKY
PYR dYPdPYdR
L
Yy L
Y
L
dL
L
dY
L
YdLdYLdy
2
5.0LY 2
50
p
wL
pwL
pwLpw
L
L
Y
pw
Y
502505.0 5.0
5.02
50
p
wY
@K.R.Bhattarai, Business School, University of Hull
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Core and Recommended Text
• Core TextsBlanchard, Oliver (2003) Macroeconomics, Third Edition,
Prentice Hall. ISBN 0-13-033772-2; http://www.prenhall.com/blanchard
Other Good texts:• Gartner Manfred, Macroeconomics, Prentice Hall.• Mankiw, G. N.(2003) Macroeconomics, Fifth Edition,
Worth Publishers, New York.• Miles David and Andrew Scott (MS) Macroeconomics:
Understanding the Wealth of Nations, John Wiley and Sons, Inc, 2002. ISBN 0-47084288-1.
• Romp Graham (1997) Game Theory, Oxford University Press. Chapters 1-10.